You won't have to guess whether you can afford that new home you want to buy using the basic recommendation of lenders for a salary-to-mortgage ratio. How much other debt you're carrying and how much of a down payment you plan on making will also affect what you may be able to afford. Starting with the lending industry's recommended percentages for mortgage payments and debt service will put you on the right track to responsible home ownership.
The standard industry recommendation for mortgage payments is that no more than 28 percent of your gross income should go to your monthly payments. To calculate this, simply multiply your annual, gross income by .28 and divide by 12. If you earn $80,000 per year, your recommended monthly payment would be $1,867.00, or an annual payment of approximately $22,4000.
The 28 percent recommendation assumes that the total amount of your gross income going toward all debt service is no higher than 36 percent. If you have credit card debt, a car payment, student loan or other debt, add that amount to your monthly mortgage payment to see if you can afford to spend 28 percent of your gross income on a mortgage. In our $80,000 example, you should be paying no more than $533 each month toward other debts, if you want a mortgage that costs you $1,867.00 each month.
You can reduce the percentage of your salary that goes toward your mortgage by making a bigger down payment. Mortgage lenders recommend putting down 20 percent of the sale price of the home to get the best mortgage rates. If you put down less, you may have to add the cost of private mortgage insurance to your monthly payments.
Shifting Debt Ratios
If your total debt-to-income ratio will exceed 36 percent, you can consider getting a smaller mortgage. For example, if you are currently paying 12 percent of your gross income for debt service, you could pay 24 percent of your gross income for a mortgage to make your 36 percent total debt figure.
You will pay more for your house the first year, because you'll have closing costs that won't occur in other years. If you plan on using the equity in your home, remember that most of your mortgage payments will go toward paying off interest at the beginning of your mortgage. Work with your lender to calculate when you will begin to have equity in your home, taking into account your down payment and monthly payments. If your house goes down in value, that will also affect your ability to take out a home equity loan.
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